Insurance Protection Gap

Sue and Tom Wright are assistant professors at the local university. They each take home about $40,000 per year after taxes.

Sue is 37 years of age, and Tom is 35. Their two children, Mike and Karen, are 13 and 11.

Sue Wright's Take-home Pay $40,000

Tom Wright's Take-home Pay $40,000

Sue Wright's Age 37

Tom Wright's Age 35

Mike's Age 13

Karen's Age 11

Present Combined Take-home Pay $80,000

75% of Take-home Pay $60,000

Less: Take-home Pay of Tom $40,000

Gap to be covered $20,000

Less: Child Support Benefit in one year $12,000

Less: Annual Child Care Expenses $600

Net Gap $8,600

Therefore the total annual needs would equal $48,600

Assuming that the kids would be Dependent until the age of 21:

Age of Youngest Child = 21-11 = 10 years

Tom would need the $48,600 for 10 years

The $48,600 would represent a stream of cash flows of which the present value is the amount that needs to be in the Family Maintenance Fund:

Assuming that inflation rate remains to be 3% (Current Inflation Rate), they would earn 3% + 3% = 6% on their investment.

This rate (6%) would be used as the Discount Rate in calculating the present value

Year 1 2 3 4 5 6 7 8 9 10

Amount $48,600 $48,600 $48,600 $48,600 $48,600 $48,600 $48,600 $48,600 $48,600 $48,600

Present Value Factor @3% 0.9709 0.9426 0.9151 0.8885 0.8626 0.8375 0.8131 0.7894 0.7664 0.7441

Present Value $47,184.47 $45,810.16 $44,475.88 $43,180.47 $41,922.79 $40,701.73 $39,516.25 $38,365.29 $37,247.85 $36,162.96

Total PV of the Cash Flow $414,567.86

Part II)

A Life Insurance Protection Gap of $50,000 means that they have an insurance for ($414,568 - $50,000) $364,568. This gap could be closed by doing the following:

1) They can contact "Affordable Term Life Insurance", once they fill out a form, they would be provided by rate information from 3...